Administrative Costs in Health Care: A Primer

I actually started looking into administrative costs a few weeks ago. But then, as if to prove the prescience of my research, Paul Krugman, Greg Mankiw, Tyler Cowen and a handful of others began arguing about the subject. And I'm not convinced any of them have it right.

Administrative costs are one of the more confusing issues in health-care reform. Start with the term: What counts as an "administrative cost" for a health insurer? We all agree that paying bills counts. But does profit? What about disease management? Advertising? A nurse who dispenses health advice over the telephone?

Hard to say. But all of them get grouped under administrative costs at various times. Indeed, I've spent the last few weeks looking into studies and talking to experts, and there's not perfect unanimity on how to measure any of this. But most seem to think that Medicare's administrative costs are significantly undersold in the public debate. An apples-to-apples comparison would not leave you with the 2 percent of total Medicare spending often bandied about in debate. That doesn't count, for instance, Medicare's premium collection, which is done through the tax code, and thus through the IRS. Nor does it count most of Medicare's billing, which is outsourced -- and this might surprise people -- to private insurers like Blue Cross Blue Shield and listed under vendor services rather than program administration. A more straightforward estimate, according to experts I've spoken to, would be in the range of 5 to 6 percent.

Nor is it easy to measure administrative costs among private insurers. For one thing, which private insurers? When the Congressional Budget Office examined this issue, it found that administrative costs -- including advertising and profits -- accounted for 12 percent of the average insurer's dollar. But that hid substantial variation among insurers. Among employer-based plans, the largest firms had the lowest costs. Plans covering companies with at least 1,000 employees had a mere 7 percent in administrative costs. Those covering companies with fewer than 25 employees spent 26 percent of premiums on administration. And the individual market was a mess: 30 percent.

This tells us a couple of things. First, size matters. The most important predictor of administrative costs is not whether the plan is public or private, but whether it is large. Second, the bulk of these costs are not helping humanity. Some conservative wags have been suggesting that Medicare's administrative costs are too low. But none of those wags, I'd wager, would prefer the small-group market to the large-group market. Others have argued that the difference in administration is that private insurers do an excellent job ferreting out fraud. unless you believe that only holds true for small business insurers, there's no evidence for that claim.

Indeed, there's little argument that large-group insurance plans offer better value than small-group insurance plans. The reasons are obvious enough: Because they don't need to spend as much money on advertising or dealing with brokers or pricing the risk of applicants, large group insurers can spend more delivering efficient medical care. The administrative efficiencies are part of that.

But administrative costs among payers -- that is to say, insurers -- are only part of the story. And they may not even be the most important part. The hospitals and physicians who have to deal with these payers are spending tremendous sums of money too. Hospitals have billing departments. They employ people to argue over claims and navigate the rules of the dozen or so different insurance plans they contract with. And here the experts were unanimous: The problem is that the system is fractured. There's no standardization. Remember the old Tolstoy quote, every unhappy family is unhappy in its own way? Well, every insurer is complicated in its own way. And that complexity costs a lot of money.

As of now, no one I spoke with knew of good data separating the costs of dealing with Medicare and with private insurers. But there are studies comparing Canada and the United States that show a single payer vastly reduces administrative spending. Few think we could achieve those savings today, even if we did convert entirely to a single payer. But there's certainly a level of savings between here and there that we could reach.

It's also important to note that you don't necessarily want administrative costs as low as they could possibly be. Some activities that are considered "administrative" are useful. Disease management, for instance, which accounts for some of the difference between Medicare and Medicare Advantage. Mental health counselors who are available by phone. Good-faith investigations into waste, fraud and abuse. Care coordination. Nurses who use e-mail or telephones to remind patients to take their drugs. Administration is not always wasteful.

But no matter how good you got at slashing administrative costs, they will never be a panacea to the problems of the system. Rick Kronick, a political scientist at the University of California at San Diego, has done some of the best work on administrative costs, and he summed the situation up quite well. "The main question," he said, "is why are health care costs going up at 2.4 percent a year faster than GDP? And most of the answers to that question have nothing to do with administrative costs. The answers are that we do more stuff and have more technology. Even if we could wring administrative savings out of the system, which I'm all in favor of and would be a good thing, we'd still be facing the question of how to slow the rate of cost growth."

Many of the administrative costs are hidden in third-party administrators, which are often for-profit affiliated companies owned by the parent non-profit or not-for-profit. It's a way to inflate costs without taking responsibility: "The TPA rates went up! It's not us!" Outlaw TPAs, and you'll be saving some serious money.

Costs go up 2.4 percent a year more than GDP because people are spending other people's money.

AND the insurance companies make it REALLY hard to get paid on covered expenses. I've spent YEARS of my life dealing with medical billing errors - and that's despite the fact that my family is healthy. These are errors in bills just from things like birthing a child and a broken ankle and well child checkups.

Talk to any doc - they go through the same hassle with some of those insurers too.

I'm self-insured. One of the few people who actually knows just how much it all costs - because I have a huge deductible and I pay for it all.

It is outrageous that my ped billed the insurance company more than $1000 for the well-child visit for my five yr old twins. ($508 per child - included two vaccines per child, two vaccine admin fees, an office visit fee and a developmental check up fee. Talk about nickle and diming to jack up the bill!)

And when I complained, the office manager said she WISHED I'd said something about self-paying when we first showed up. They could bill differently, if only they knew it was out of MY pocket, not the insurance company.

When my son had a lingering cough, the ped decided to order not one, but two tests for pertussis, an illness he'd been vaccinated against. An illness he had a small chance of actually having. The "bill" for the tests was for $357, but the deal for me - they wrote off $300. I get to pay $50. (Insurance paid nothing.)

That's just not a real cost - that $357 for the pertussis tests - it's a fake number that people push around and spin the tail on the donkey and roll the dice - and look, we've come up with $57 that you REALLY owe us. It's absurd, that's what it is.

I cannot imagine what happens when you actually are seriously ill - it is a disaster, to become ill in this country. An utter disaster. And unfortunately, seriously ill people are not "too big to fail" and thus, there's no one with a fat handout to bail us out should we become seriously ill.

^ At risk of self-promotion, my organization recently did a report looking at the medical loss rations (= amount spent on actual health benefits, vs. administration, overhead, etc.) which surveys what that number is for a bunch of insurers:

http://tinyurl.com/ltfv6r

As to the Canada comparison, as Ezra says, it's hard to see how exactly we get there from here. And given the fact that Medicare's medical costs per enrollee are higher than those of private insurers (Medicare covers older people. Private insurers cover younger people, and actively try not to cover sick people), the percentages can be a bit misleading.

None of which is to say that there's not a lot more we can do in this area! There's a lot! But it's not the magic bullet.

I forgot these questions for Mike Russo. Do you have an estimate on how much we would save if we passed HR676 (minimizing private insurance) and eliminated Drug marketing including the pushers and the payments to physicians?

Assuming we institute a simple form for physicians to use like in France and that Medicare would continue to have many fewer physician and patient problems (cf recent Commonwealth Fund Study) than private insurers, do you believe that HR676, Super Medicare for All, would pay for itself, i.e. would cover everyone and cost no more than we are now paying?

We should not care about whether something is an admistrative cost or not. Either it is spent for medical benefits or it is not. Thus Medical Cost Ratios (MLR's) are the correct statistic.

"First, size matters."

This is yet another argument for Medicare for All.

" Few think we could achieve those savings today, even if we did convert entirely to a single payer."

Reference plaese? I don't know why everyone sells America short.

"The main question," he said, "is why are health care costs going up at 2.4 percent a year faster than GDP? And most of the answers to that question have nothing to do with administrative costs."

Right. The point is that many (at least one) believe we could wring enough savings out of overhead and compliance costs and drug prices to give decent health insurance to everyone. We would still be paying twice as much as everyone else and our costs would still be rising too fast, but at least people would not be going bankrupt or dying because they lacked decent health insurance. Furthermore the evidence seems strong that if you have a government run system like in other countries, you will be in better shape to tackle these two problems (spending too much now and rising too fast). If you believe in the projections you fling around so blithely, you should believe in the CEPR calculator (http://www.cepr.net/calculators/iousadeficit/calc_iousa_deficit.html) which tells you the rising too fast problem has been solved. All we have to do is pick from the 23 solutions listed below the calculator.

According to SEC filings of the six largest for-profit insurers, medical loss ratios are typically around 82 percent. Kahn and Kronick have shown that the administrative burden that private insurers place on physicians and hospitals consumes about another 12 percent of health insurance premiums, leaving a net of about 70 percent for actual health care spending.

Adding a public option would have very little impact on reducing these administrative excesses. Nor would limiting insurer medical loss rations to 15 percent since that would not reduce the burden on the providers. Efficiencies would be gained by displacing our fragmented multi-payer system with a single public plan. Though this is very important, it is only one element accounting for the greater value of a single payer system.

Anderson and Reinhardt have shown that health care prices are a much greater cost problem than high-tech services. The administrators of a single payer system would negotiate prices to provide greater value. Hospitals would be reimbursed by much more efficient global budgeting. Capital improvements would be negotiated separately thereby reducing supply-side excesses. Incentives would be realigned to provide much needed reinforcement of a more efficient and less expensive primary care infrastructure.

Establishing our own public single payer monopsony would provide far more than a one-time benefit since the administrative changes would bend the curve of health care cost increases down to a more sustainable level well into the foreseeable future.

Although the administrative savings are very important, it would be a mistake to dismiss single payer as merely a method of achieving a one-time reduction in insurer administrative costs. Not only would costs be contained, but everyone would be included automatically, and the financing would be equitable, making it truly affordable for everyone. It would actually achieve our goals for reform, and at a much lower cost than the current proposal before Congress.

Another factor that is not considered is what private insurers do with the premiums. Like all insurance companies they invest them. The profits from these investments (essentially the float on the premiums, which is why the pay slowly) aren't considered.

One of the standard tricks of traditional life insurance is for the salesman to demonstrate how your heirs actually get back all the money you paid in premiums over the years, neglecting the earnings that these premiums generated for the firm.

The big insurance companies have been doing poorly with their investments, just like all the other financial players and their stocks have been in disfavor as a result.

When you add in the 10% or so they were earning to the 20% loss ratio they were a gold mine and this was reflected in the CEO's pay.

I actually do have some information regarding the difference between overhead expenses for Medicare and overhead expenses for private insurers for providers.

I am a doctor. My billing agent belongs to an organization of billing agents. She tells me that statewide (she doesn't have national data) billing private insurers costs about 11% of amount billed, while Medicare costs about 3%.

In her own business, the ratio was even more striking. She reports that private insurers cost her about 7 times as much to deal with as Medicare. In fact, the structure of her business is such that she makes all her profits from billing Medicare and actually loses money billing private insurers. She charges us the same amount for billing both.

She shared this info because she is retiring and closing her business, and is trying to help us with setting up a new service.

Medicare loses hundreds of billions of dollars to fraud and waste every year because of their incompetent administration. If private insurers did that they would go out of business.

Your post seems to boil down to this: Conservatives are right about Medicare's administration costs but it doesn't really matter anyway and I talked to a lot of experts that I already knew agreed with me and I love Paul Krugman and the Government can do everything better QED.

Unfortunately, private insurers deal with fraud and waste mostly by ignoring it and factoring it into their charges. Medicare is specifically required to investigate fraud and has the power of the federal government to do so, so they do often find fraud. The few serious investigations of fraud in private insurance -- there was one a few years ago by a newspaper in New Jersey -- have found significant incidence of fraud.

No one is doing much about waste. Waste, which predominantly takes the form of overuse of high tech management and of preventable errors, is largely ignored by all payers. People who are serious about error prevention and quality assurance tear their hair out because of the lack of interest. No one except the Dartmouth people seems to have much interest in overuse.

Obama and his people are making noise about both those issues, but it remains to be seen what they will actually do, since this is the big third rail in health care because of raising the question of whether providers and suppliers are doing the job they should be doing, a question that is not very welcome in many circles.

Lensch: glad you found the report useful! If you read the full pdf and go to the appendix at the end, you'll find tables with MLRs for many big insurers.

I admit that I'm not too up to date on cost-savings estimates for national single payer plans, but I think it's inarguable that it saves money over just about any reasonable time horizon. I know the Lewin Group did such a study for California in specific, and found about $7 billion in annual savings (significantly less than you'd expect in a nationwide rollout, of course).

As to drug company marketing, I've actually been doing a little bit of work on this -- there aren't a lot of good sources on this, unfortunately, as it's a bit difficult to predict firm behavior, but a conservative estimate is that some moderate restrictions (i.e. those that steer well clear of even arguable 1st Amendment issues) could generate savings on the order of $20-30 billion per year.

You also mentioned moving to standardized forms -- switching from the current system to one with uniform forms and coding, and connecting payers and providers in secure data interchange networks, is also something that can generate a reasonable amount of savings. We spend about $80 billion on this stuff per year, and successful initiatives in Utah and New England how shows you can get this way down. Single payer could add some additional savings on top of this, but really the key thing is the administrative streamlining and the electronic hook-ups.

Fallsmeadjc: Doug Holtz-Eakin (former McCain campaign advisor and CBO head) seems to think that Medicare fraud is $60 billion or less per year. And that strikes me as at the very least a vast overestimate on the amount of potential savings, given that I've seen proposals to crack down on Medicare fraud scored as saving $2-3 billion per year.

I have heard time and time again that private insurers are evil because the refuse care. Well, that's what has to be done when it's all prepaid. That's why we are spiraling out of control- we are being overtreated, and we are getting the latest, most expensive, and most frequent care. We need to slow the growth and availability of better health care technology, because we can't afford it. It doesn't matter if we're the richest nation on earth, we can't afford everything.

We have access to the best care in the world. Deny it all you want, but given the health habits of the average obese American, it is a medical miracle that our life expectancy is anywhere near that of the Japanese.

Administrative costs are not the problem. A system where the consumer bears so little of the cost burden, where the incentive is to maximize your use of the system is messed up. Look at the TOTAL average amount of money spent per Medicare patient per year. Compare it with the average amount of money spent per privately insured individual per year. If the total amount is not lower, (and it's not lower, it's much higher) you spend more money by switching to a Medicare style plan.

PatS2: you're completely right that, for all that we can lower administrative costs, ineffective treatments and overutilization are really what drive health care costs, and where the real potential savings are at.

With that said, there are some good delivery and payment reforms currently on the table -- if we get a strong comparative effectiveness research regime, and get some strong payment reform rolled out in Medicare and (hopefully) the public plan, we might get to a place where we can start bringing these costs down and increassing quality at the same time.

Staticvars: er, you do understand why the average 65+ year old might cost more in terms of medical care than the average 40 year old, right?

Other than that I agree with much of what you say, with the qualifier that very often, the latest, most expensive, most frequent care is actively bad for our health. It's not a questioning of rationing care -- it's a question of improving it, and saving money while we're doing it.

Mike - Thanks again for your report. You say, "moderate restrictions (i.e. those that steer well clear of even arguable 1st Amendment issues) could generate savings on the order of $20-30 billion per year."

Have you consider the savings by eliminating pushers, say, by requiring them to have an appropriate degree or the savings obtained by putting strict limits on physicians payments by drug companies?

Alan Sager of BU has computed that drug companies spend of a third of their budget on marketing. I believe this would amount to $100 Billion a year.

I agree that it is encouraging that there finally seems to be some serious attention being given to the issues of effectiveness, cost effectiveness, and even to quality issues and error prevention. The interest in using Medicare as the point of the spear in this type of reform is also heartening.

The critical steps in this reform are to create an agency to collect and commission studies on questions of effectiveness and safety and to give some agency (Obama proposes MedPAC) enough strength and independence to intitiate and enforce the policies. The usual suspects will line up their lobbyists to combat these reforms which threaten their self interest.

One of the strongest arguments I know for the strong federal option is that it would strengthen the hand of people trying to initiate these reforms by expanding the number of people subject to the reform, and would act as a wedge to stimulate private insurance companies to use similar efforts for competitive cost reasons.

David Leonhardt has a very good article in today's NYT about the issue, using prostate cancer as his case example.

“Unfortunately, private insurers deal with fraud and waste mostly by ignoring it and factoring it into their charges. Medicare is specifically required to investigate fraud and has the power of the federal government to do so, so they do often find fraud. “

I don’t think that’s a fair generalization Pat, with regard to the private insurer part. If for no other reason that it’s a market driven, outsourced function, i.e., there are firms/software that specializes in this. As for the Medicare piece, their fraud investigations are also certainly helped by those in the industry who are not unaware of the False Claims Act.

Administrative costs are really the fault of the employer-based system. Specifically, plans try to create all these specially tailored products for employers and you’ve now got 8 different kinds of Aetna/United/Humana products in a region, and dozens of regions across the country, and all those different kinds of plans in different regions require different contracts, and different negotiations and different technical infrastructure, and people maintaining changes to that technical infrastructure and those contracts, etc. You also increase the likelihood of claims being paid according to the wrong contract, and people to research that and make the correction. It all started, actually, in the somewhat well-meaning market-driven way of wanting to give the customer some good options, options that were custom built for the customer’s needs. This resulted in such a plurality of products that administrative costs have gone through the roof.

You are correct that the real issue is why our health costs are so much higher than other countries that seem to deliver the same level of care. Admin is only one of many reasons, and may be less than 10% of the problem.

I think addressing the components may be a bad strategy. A better strategy might be to focus on the overall cost issue. Since excess health costs are at least 10% of wages, everybody could get a 10% raise if we fixed it. So statements like "The average family of 4 pays $8,000 more than a German family for worse healthcare" might be a better line. It is simpler. Or "The amount you pay to the government now in taxes is enough to completely pay for the German system, so every premium dollar you have ever spent is completely wasted. Wouldn't you rather get a $5,000 raise?"

The problem with debates at the detailed level is you always have right-wingers or right-wing-enablers from the Post coming up with "Oh it's only 7% versus 5% or 6%", completely ignoring that UnitedHealth sucks out 18% to 19% of the premium. The detailed argument quickly gets diluted.

A recent Robert Woods Johnson Foundation study of the costs of medical billing estimates that it costs $31B per year or almost 7% of spending on physician and clinical services.
http://www.rwjf.org/about/product.jsp?id=42728

For the academic wonk, it is good to be familiar with the argument put forth in Patricia Danzon's 1992 Health Affairs article:

http://healthaff.highwire.org/cgi/reprint/11/1/21.pdf

She argues that in Canada, administrative costs (of the moral hazard variety) get shifted to the consumer in the form of longer waiting times. This is an interesting conceptual issue to consider despite its negative stance.

Pedro, you say that wait times in other countries are longer than those in the US, but that only looks at the patients who actually received the treatment. Since everyone is covered in the other countries, that does not effect the result, but in the US where millions have no insurance, there are many people who need surgery who never get it. The statistics ignores these people whose wait time is infinite. Obviously if you only give a benefit to some of the people you can do it faster.

Actually the waits are nowhere near what the conservatives say. For Canada, go to http://canadaonline.about.com/od/healthcarewaittimes/Wait_Times_for_Health_Care_in_Canada.htm

Furthermore the reason the wait time are longer for these benefits has nothing to do with the fact that other countries have more efficient systems, but because they spend less than half per patient than we do. I invite the reader to try to imagine the wait times in our system if we cut health care payments by over 50%.

Finally, the bottom line is that if you look at all the 16 basic public health statistics (life expectancy, infant mortality, etc.) or the WHO rankings, these other countries provide much better health care and they do it at much less cost.

The focus on administative costs is misplaced. As you say, overuse of advanced medical technologies is what drives health care inflation. And this not only make care needlessly expensive, it exposes patients to risks and side effects without benefit.

It's dangerous.

Until people understand this, they are not going to be able to understand President Obama's health reform goals.

Stop and think about when the last time you read about private health insurance catching fraud, all the while remembering that a very important part of deterring fraud is publicizing the results of catching violations.

As a physician I can tell you that nothing in the claims systems of the private insurers I dealt with seemed to have anything to do with preventing fraud.

The conclusion seems to be that one of two things is going on: either private insurance is never victimized by fraud, or private insurers are ignoring fraud, shifting the cost of fraud prevention to the public programs.

Thanks, lensch. In my previous comment I didn't mean to imply that non-beneficial high-tech excesses aren't a problem, they are. The Dartmouth studies certainly confirm that, as mahar1 keeps reminding us. The problem is that placing restrictions on these services would be a very blunt instrument, interfering with the provision of truly beneficial health care services. A more effective approach would be to return primary care to a dominant role since specialized services are used more efficiently in such a model wherein the patient receives better guidance from his or her health care professional. Limiting supply-side excesses through planning and budgeting also improves efficiency.

The point is that not only would the administrative excesses of our dysfunctional financing system be reduced, the stewards of a single payer monopsony would spend more wisely by appropriately realigning incentives. We would be replacing an excess of administrative services that interfere more than help, with much less costly administrative services that would greatly improve value in our health care purchasing.

dmccanne - I completely agree; It seems obvious to me that our severe problems with medical practice would be better handled under a single payer system, but frankly I am getting totally paranoid.

When I was young (I am 70), US car cos made unsafe cars. They financed research into other factors like speeding and drunk driving, so their cars would not be regulated. Now speeding and drunk driving were imporatant factors, but so were poor maintence of cars and roads, and poor design of cars.

Somthing similar is happening today. We are being pointed to the difficult problems of medical practice and the deep philosphical question of how much a day of life is worth and away from, as I said above, the low hanging fruit. And the bad guys are winning.

To me the biggest reason for the explosion in health costs is the massive amounts of money we spend on people in the last six months of life. We need more people to go into hospice rather than spending money on terminal persons in heroic efforts which do not make the persons life any better. A friends mother 84 years old had a stroke and was in a coma, the doctors told the family that the mother had less than a 5 percent chance of ever waking up. She then developed blood clots in her lower legs. Because of the clots she would either need surgery to amputate her legs, or they could just let her pass. The family said "we can't let mom die and gave persmission to amputate both legs". The woman died before surgery was undertaken. This would have been a complete waste of money and would not have helped this womans quality of life at all.

We also have physicians who have no financial interest (in most cases) ordering tests, dme, and other medical services, just to cover themselves against malpractice or to keep patients happy. You would not believe the stuff my doc has ordered for me. An MRI on my liver, an ultrasound of my neck, a stress test, dozens of lab tests, etc., all for a healthy 47 year old who works out 4 times a week and the only abnormal reading on any test is a slightly elevated top number in my BP readings. Plus you have the adverising of drugs and things like wheelchairs. If under Medicare a doctor can order a $4,500 wheelchair to be paid by Medicare because the elderly person wants to be able to ride around disneyland, even though they do not need it for the activities of daily living, there is no penalty for the ordering physician. I believe in many cases the doctor signs the necessary forms just to get the patient or patients children off their back.

this article is right on point..the greatest opportunity to reduce a component of adminsitrative costs is the labor expended to get a bill authorized and paid..Under the administrative simplification act of 1996,there was established e-commerce transactions(HIPAA business transactions)that would have reduced the costs to get a claim paid however the transactions were not made mandatory..as a result hospitals and payers continue to expend costs that add no value to the quality of health care in the united states..since this is seen "as a good thing" , we need to mandate these transactions as soon as possible..